Wednesday 20 December 2006 19.01 EST
First published on Wednesday 20 December 2006 19.01 EST

The City was last night betting heavily on a new year increase in interest rates after the release of figures showing record mortgage lending to a booming property market and a surge of pre-Christmas retail spending.

Fuelling concerns that strong demand would fuel inflationary pressure in the economy, the British Bankers' Association said higher borrowing costs had so far failed to dampen appetite for home loans while the CBI reported the strongest retail sales for two years.

Minutes of the December meeting of the Bank of England's monetary policy committee (MPC) revealed a unanimous 9-0 vote in favour of leaving the cost of borrowing unchanged at 5%, but sterling was within three cents of the $2-level against the dollar last night as the City's money markets signalled that rates would be raised to 5.25% by March.

The Royal Institution for Chartered Surveyors - the body that represents estate agents - said the housing market would have a buoyant start to 2007. House prices are already rising at an annual rate of almost 10%, with some analysts predicting that property inflation will climb to 15% by the end of next year.

David Stubbs, senior economist at the RICS, said: "These figures, coming only days after another strong survey of the market by the RICS, are yet further proof that the housing market will enter 2007 with significant momentum. Housing demand will continue to outstrip supply leading to continued price gains throughout the year and tempting the Bank of England to raise interest rates at least once, if not more, in the first six months."

The British Bankers' Association said record demand for mortgages in November had been accompanied by a renewed appetite for consumer debt. Net mortgage lending (new advances less loans repaid) rose by £6.5bn in November, a hefty increase on October's £5.6bn and the average of £5.7bn over the past six months.

David Dooks, director of statistics at BBA, said: "This shows just how strong secured lending is and how, as yet, demand has not been moderated by the climate of higher interest rates." Credit card lending, after falling by an average of £248m a month between May and October, rose by £66m in November as consumers ran up debts to finance spending.

The latest snapshot of retailing from the CBI showed that talk of a poor Christmas for shops and stores might prove too pessimistic. Almost half the retailers questioned said sales were higher in the first two weeks of December than they were a year earlier, while only 22% said they were lower.

Supermarkets and specialist food stores were the best performers, according to the CBI's distributive trades survey, followed by footwear and leather outlets. Many retailers fear, however, that they may pay for a strong December with weaker consumer spending in January. Almost as many stores believe sales volumes will fall year-on-year next month as expect them to rise.

John Longworth, executive director of Asda and chairman of the CBI's distributive trade panel, said: "After a slow start in the run-up to Christmas, sales are really beginning to build. In the first two weeks of December, retailers' sales volumes outshone their expectations, proving that good things can come to those who wait. The last 10 days have been very good."

In his own stores, Mr Longworth said sales of flat-screen TVs at £99 had "been flying off the shelves". Asda sold 13,000 on the first day of the offer last weekend, he added.

"For some retailers, this volume growth will have been achieved at the expense of discounting," Mr Longworth said. "With expectations for only slow growth in January - though this may be given a boost by further discounting - retailers are hoping they can avoid a repeat of last spring's falling sales volumes."

The City believes the Bank of England will maintain its wait-and-see approach until the release of its next quarterly inflation report in February and will then push up interest rates again.

Yesterday's minutes showed some members of the MPC had been concerned about the upside risks to inflation from the property market and the growth in the money supply, while others placed more weight on the downside risks from a weaker American economy, slack in the British labour market, and recent soft consumption growth.

Wage worries

The International Monetary Fund stressed last night that Britain needed wage restraint and a tough public-spending round in 2007 if it was to maintain its "impressive" economic performance.

In its annual health check, the IMF said taming the increase in inflation caused by higher energy prices was "a challenge" and warned that further rises from the Bank of England might be needed.

The IMF added that moderation in pay settlements would be required to keep rises in the cost of borrowing to a minimum. Gordon Brown has already caused anger in the public sector by calling for wage increases to be kept to 2% next year but the IMF said a slowing in real wage growth was "inescapable".

The organisation's annual Article 4 Consultation with the UK said: "For the immediate future, continuing to communicate the importance of wage restraint will help minimise the need for increases in interest rates."

The IMF said it strongly supported the government's plans to first stabilise and then lower public spending as a share of GDP (gross domestic product) but warned: "This will require tough choices in the comprehensive spending review, particularly as important infrastructure needs argue for maintaining capital spending as a share of GDP at its current level."

Figures released yesterday by the Office for National Statistics showed that the government was in the red by £9.9bn last month, only a slight improvement on the £10.2bn deficit in November 2005.

Analysts said that without an improvement in the final four months of the financial year, the chancellor would struggle to meet his forecast of a £37bn deficit for the year.